Crude economics

India needs deeper fiscal reforms

India’s macroeconomic outlook often changes, depending on the level of crude oil prices. As a large importer of energy, India does relatively well when oil prices are low and stable. A significant rise in crude oil prices increases policy challenges. It leads to a higher current account deficit and puts pressure on the currency, which needs careful management. Higher oil prices also result in higher inflation and increased stress on government finances. Crude oil prices have gone up by about 48 per cent since the beginning of the year. To contain inflation, the Union government last week decided to reduce taxes on petrol and diesel, which would lead to an annual revenue loss of Rs 1 trillion. It also announced a subsidy of Rs 200 per gas cylinder for the beneficiaries of the Pradhan Mantri Ujjwala Yojana, which will cost Rs 6,100 crore. Along with other measures, such steps will put pressure on government finances. The government is targeting to contain the fiscal deficit at 6.4 per cent of gross domestic product (GDP). 

Besides macroeconomic challenges, higher oil prices have also resulted in the reversal of the price decontrol reform. State-run oil marketing companies have virtually stopped adjusting retail prices of petrol and diesel. As a result, the system of under-recovery is back. According to one estimate, the under-recovery for petrol is over Rs 13 per litre and Rs 24 for diesel. This is an unsustainable position. It is also affecting private retailers who do not have any pricing power. Most of the market is controlled by public sector companies. Consequently, private companies are reportedly looking to scale down operations to cut losses. If the present situation prevails, it is reasonable to assume that they would be looking to exit. This way India would never be able to attract private investment in the sector and will be deprived of efficiency benefit, which usually comes with opening up and leads to competitive pricing. It will also become more difficult for the government to find takers for Bharat Petroleum Corporation.

Since India heavily depends on oil imports, part of the problem that arises because of higher prices is unavoidable. However, some of it is also of its own making. The government depends heavily on revenue from the petroleum sector. In 2020-21, for instance, the contribution of the sector to the central exchequer was over Rs 4.55 trillion, which was 2.6 times more than in 2014-15. To provide tax stability, the government will have to reduce its dependence on petroleum products and raise revenue from other sources. Rationalisation of taxes will also allow petroleum products to be included in the goods and services tax net, which will enable taxpayers to claim input credit. The government can impose a separate carbon tax, which can be transparently used to fund green projects.

India thus needs deeper fiscal reforms. It needs to review both direct and indirect tax systems to materially push up the tax-to-GDP ratio. The government will also need to rationalise expenditure to prioritise growth. Further, it should avoid interfering in pricing, which was the intent behind price decontrol. Holding prices could, in fact, worsen the problem over time. Overall, while some economic pain is unavoidable, the government can contain macroeconomic vulnerability by maintaining a strong fiscal position and allowing transparent pricing. On the external front, the currency should be allowed to adjust in an orderly manner to reflect changes in the current account.